Qualified mortgages were created in 2014 to make it more likely that a borrower who’s approved for a home loan can afford and pay back that loan. Lenders now need to carefully assess a home buyer’s ability to repay, and borrowers must meet stricter criteria than they did more than a decade ago.
If borrowers don’t meet the revised criteria, they won’t be approved for a qualified mortgage. This is where nonqualified mortgages come in. While nonqualified mortgages sometimes have a bad reputation, they might be the right choice for some borrowers. To help you make an informed decision concerning qualified and nonqualified mortgages, here’s what you need to know about both options.
What Is A Qualified Mortgage?
A qualified mortgage loan (QM loan) meets all the consumer protection requirements of the Consumer Financial Protection Bureau (CFPB). Borrowers must have a reasonable debt-to-income ratio (DTI), and mortgage lenders can’t offer mortgage products with artificially low introductory monthly payments that sharply increase when the teaser period ends.
What Are The QM Rules?
To understand what a qualified mortgage is, it’s helpful to look at the requirements that lenders want you to meet before they’ll offer you a qualified mortgage. Qualified mortgages can’t have:
- Risky loan features: Lenders can’t offer artificially low monthly loan repayments in the early years of the loan term or provide loans with risky features. Examples include interest-only loans, balloon payments and negative amortization.
- A high percentage of a borrower’s income going toward their debt: There are limits to how much of a borrower’s income they can put toward their debt. The amount of your income that goes toward your debt is known as your debt-to-income ratio (DTI), and it generally can’t exceed 43% – 57%, depending on your lender and the type of loan.
- Excess upfront costs and fees: The limit on costs and fees will vary by the size of the loan, but if costs and fees are over the threshold, the loan can’t be considered a qualified mortgage.
- A loan term longer than 30 years: Lenders must offer loans with a repayment term of no more than 30 years. Most often, borrowers will be able to choose a 15-year or 30-year
A qualified mortgage also indicates your lender has followed the “ability to repay” rules, meaning they’ll ask about and document your assets, credit history, employment, monthly expenses and income. For your income, they’ll review your W-2s and pay stubs in an effort to figure out if you can repay the loan they’re thinking of offering you.
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What Is A Nonqualified Mortgage?
Unlike a qualified mortgage, a nonqualified mortgage (non-QM loan) doesn’t conform to the consumer protection provisions of the CFPB. Applicants who have an income that varies or who face other unique circ*mstances, such as being a freelancer or side-gig worker, may qualify for this type of mortgage.
For example, if your DTI is higher than the maximum allowed, a lender may not be able to offer you a qualified mortgage. Or, if you have erratic income and don’t meet the income verification requirements set forth by the CFPB, you may not be eligible for a qualified mortgage.
A lender may instead decide to offer you a nonqualified mortgage. If so, it doesn’t mean the lender won’t do any verification or assessment of your ability to repay the loan; it just means you don’t meet the specific criteria for a qualified mortgage. Lenders can perform manual underwriting to verify your income using bank statements, 1099s, tax returns and other applicable documentation.
Interest rates on loans will vary from lender to lender, but you may find that a nonqualified mortgage will have a higher interest rate and higher down payment. If that’s the case, it’s because lenders often find these loans riskier since the borrowers who apply for them typically have more debt and a less stable income.
Who Can Benefit From A Nonqualified Mortgage?
Most borrowers end up with a qualified mortgage. However, a nonqualified mortgage is an easier option in some circ*mstances. This may be the case for the following types of borrowers:
- The self-employed
- Business owners
- Those with higher levels of debt
- Those with a low credit score
- Real estate investors
- Freelance or gig-economy workers with a varying income
- Foreign nationals
Nonqualified mortgages allow these borrowers to get into a home more easily than they could with a qualified mortgage.
FAQ
While differences exist in how you qualify for a qualified mortgage versus a nonqualified mortgage, the actual loans also have their differences. Here are a few frequently asked questions – followed by their answers – so you can better understand your options.
What legal protections do qualified mortgage loans offer?
The CFPB offered lenders issuing QM mortgages protection from legal challenges in foreclosure proceedings and other litigation. With a QM mortgage, lenders have shown they made sure borrowers had the ability to repay their loan. This gives lenders legal protection from lawsuits claiming the lender didn’t verify a borrower’s ability to repay. However, if a borrower doesn’t believe a lender ensured they had the ability to repay, the borrower can still challenge the lender in court.
Additionally, only QMs can be insured, guaranteed or backed by the FHA, the VA, Fannie Mae or Freddie Mac, so these loans are safer for investors who buy mortgage-backed investments.
How do lenders verify income for nonqualified loans?
Non-QM loans offer flexibility for lenders to offer mortgages to people who don’t meet the criteria for QM loans, but lenders still need to do the work of verifying the information provided. Lenders must verify and document everything, including income sources, that supports the borrower’s ability to repay. Lenders may also want to verify assets or anything else that gives them assurance the borrower can repay the loan.
Non-QM loans aren’t insured, guaranteed or backed by the FHA, the VA, Fannie Mae or Freddie Mac.
What’s the benefit of applying for a qualified mortgage?
A qualified mortgage is the most common type of loan. Applying for a qualified mortgage means you’re more likely to have a loan with a lower interest rate and a monthly payment you can afford.
What’s the benefit of applying for a nonqualified mortgage?
Nonqualified mortgages allow borrowers who otherwise wouldn’t qualify for a mortgage to be eligible for a home loan.
If you have a low credit score, a high debt-to-income ratio or an income that varies enough for a traditional mortgage not to be an option, a nonqualified loan may be the right fit for you.
How can I apply for a non-QM loan?
If you’re a self-employed borrower, your credit is less than stellar or your income doesn’t meet the traditional W-2 standards that a qualified mortgage loan requires, a nonqualified loan might be your best bet.
To apply for a non-QM loan, you’ll need to research lenders and find a loan option that works for your needs. From there, the lender’s online resources or a representative can help guide you through the application process.
How can I tell which type of loan is right for me?
If you can’t qualify for a qualified mortgage, ask your lender to explain why. If they tell you it’s due to unstable income, higher-than-allowed DTI, a low credit score or a similar issue, a nonqualified mortgage may be a more suitable option.
However, if you have a stable income, a DTI below the maximum allowed and good credit, a qualified mortgage is a better choice.
The Bottom Line
Taking out a non-QM loan can be the way to go for some borrowers who are unable to secure a qualified mortgage loan due to unreliable income, a high DTI or a low credit score. However, lenders still have standards for non-QM borrowers and need to assess the borrower’s ability to repay. That said, the requirements for non-QM loan approval are certainly more relaxed.
Even so, an alternative to a nonqualified mortgage will be a better fit for some borrowers who aren’t eligible for a qualified mortgage.
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